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Second Department Affirms Dissolution of Closely Held Corporation Due to Deadlock Between Shareholders

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  • Posted on: Dec 26 2018

New York’s Business Corporation Law (“BCL”) provides shareholders owning 50% or more of a corporation two paths to judicial dissolution: a) BCL § 1104 – deadlock at the board or shareholder level such that the corporation “cannot continue to function effectively, and no alternative exists but dissolution”; or b) BCL § 1104-a – where directors or those in control of the corporation have been guilty of illegal, fraudulent or oppressive actions toward the complaining shareholder(s).

Dissolution Under the BCL

Under BCL § 1104, dissolution may be ordered where deadlock between shareholders establishes that the corporation “cannot continue to function effectively, and no alternative exists but dissolution.” Molod v. Berkowitz, 233 A.D.2d 149, 150 (1st Dept. 1996), lv dismissed, 89 N.Y.2d 1029 (1997); Neville v. Martin, 29 A.D.3d 444, 444-45 (1st Dept. 2006); Matter of Cunningham & Kaming, 75 A.D.2d 521, 522 (1st Dept. 1980).  In this regard, a shareholder owning at least “one-half of the votes of all outstanding shares of a corporation entitled to vote in an election of directors” may petition the court for dissolution based on one of the grounds set forth in BCL § 1104: (1) the directors are so divided about the management of the corporation’s affairs that the votes required for action by the board cannot be obtained; (2) the shareholders are so divided that the votes required for the election of directors cannot be obtained; and (3) there is internal dissension and two or more factions of shareholders are so divided that dissolution would be beneficial to the shareholders. BCL § l 104(a).

Once a petitioner has established a prima facie showing of entitlement to dissolution, it is within the court’s discretion whether to issue an order granting dissolution. BCL § 1111(a).

Dissolution is generally appropriate where the complained of internal dissension and/or deadlock impedes the daily functioning of the corporation (see generally Hayes v. Festa, 202 A.D.2d 277, 277 (1st Dept. 1994)), thereby “pos[ing] an irreconcilable barrier to the continued functioning and prosperity of the corporation.” Matter of T.J. Ronan Paint Corp., 98 A.D.2d 413, 421 (1st Dept. 1984). Notwithstanding, “dissolution and forced sale of corporate assets should only be applied as a last resort.” Matter of Klein Law Group, P.C., 134 A.D.3d 450 (1st Dept. (2015) (quoting Matter of the Dissolution of 168½ Delancey Corp., 174 A.D.2d 523, 526 (1st Dept. 1991) (internal citations omitted)).

“In determining whether dissolution is in order, the issue is not who is at fault for a deadlock, but whether a deadlock exists. Matter of Kaufmann, 225 A.D.2d 775 (2d Dept. 1996). “[T]he underlying reason for the dissension is of no moment, nor is it at all relevant to ascribe fault to either party. Rather, the critical consideration is the fact that dissension exists and has resulted in a deadlock precluding the successful and profitable conduct of the corporation’s affairs.” Matter of Goodman v. Lovett, 200 A.D.2d 670, 670-71 (2d Dept. 1994).

As noted, the threshold requirement for seeking dissolution under BCL § 1104 is ownership of at least 50% of the shares entitled to vote for directors. BCL § 1104(a) (the party seeking dissolution must hold “shares representing one-half of the votes of all outstanding shares of a corporation entitled to vote in an election of directors ….”). This requirement is strictly construed by the courts. Thus, where a party owns less than 50% of the voting shares, dissolution will be denied. See In re Sakow, 297 A.D.2d 229, 230 (1st Dept. 2002) (“The IAS court properly found, however, that one share of the stock claimed by petitioner had been sold, leaving petitioner short of the 50% stock ownership required, depriving her of standing to bring this action and requiring dismissal.”).

The ownership requirement (50% of the shares) has two exceptions, which are set forth in BCL §§ 1104(b) and (c). Under BCL § 1104(b), if the corporation’s certificate of incorporation requires a super-majority for board action or an election of directors, the petition may be brought by the holders of shares representing “more than one-third” of the voting shares. Notably, a super-majority requirement in a shareholders’ agreement, where such provisions are commonly found, does not fall within the exception.

Under BCL § 1104(c), any holder of voting shares, regardless of percentage, can petition for dissolution “on the ground that the shareholders are so divided that they have failed, for a period which includes at least two consecutive annual meeting dates, to elect successors to directors whose terms have expired or would have expired upon the election … of their successors.”

Under BCL § 1104-a, the court has the power to order the dissolution of a corporation where “[t]he directors or those in control of the corporation have been guilty of illegal, fraudulent or oppressive actions toward the complaining shareholders” (BCL § 1104-a, subd. (a), par (1)) or where “the property or assets of the corporation are being looted, wasted or diverted for non-corporate purposes by its directors, officers or those in control.” BCL § 1104-a, subd. (a), par (2). Dissolution under this section is discretionary. Gimpel v. Bolstein, 125 Misc. 2d 45, 49 (Sup. Ct., Queens County May 30, 1984) (citing Matter of Topper v. Park Sheraton Pharmacy, 107 Misc. 2d 25, 28 (Sup. Ct., N.Y. County Oct. 24, 1980)). It is a “drastic” remedy, and before ordering dissolution the court must consider whether it is the only means by which the complaining shareholders can reasonably expect to receive a fair return on their investment or whether it is reasonably necessary to protect their rights and interests. Id. (citing BCL § 1104-a, subd. (b); Muller v. Silverstein, 92 A.D.2d 455 (1st Dept. 1983)). The corporation or any of its shareholders may avoid the proceeding by electing to purchase the petitioner’s shares at their fair value. Id. (citing BCL § 1118).

Matter of ANO, Inc. v. Goldberg, 2018 N.Y. Slip Op. 08476 (2d Dept. Dec. 12, 2018) (here).

Recently, the Appellate Division, Second Department, affirmed the dissolution of a closely held corporation under BCL § 1104(a) because the dissension between the shareholders “posed an irreconcilable barrier to the continued functioning and prosperity of the corporation.” T.J. Ronan Paint, 98 A.D.2d at 421.

ANO involved a petition by Arieh Yemini (“Yemini”) to dissolve ANO Inc. (“ANO”), a closely held corporation jointly owned by Yemini and Goldberg Commodities, Inc. (“Goldberg Commodities”). Each owner holds a 50% share in the corporation. Oded Goldberg (“Goldberg”) owns 100% Goldberg Commodities.

ANO’s primary asset is its two-thirds ownership interest in Candlewood Holdings, Inc. (“Candlewood”). Rosalie Moore holds the remaining one third interest in Candlewood.

Yemini, as a 50% shareholder of ANO, filed suit to dissolve ANO pursuant to BCL § 1104. Yemini claimed, among other things, that he and Goldberg were deadlocked over the affairs of the corporation such that their dissention constituted an irreconcilable barrier to the continued functioning and prosperity of the corporation. Matter of Kaufmann, 225 A.D.2d at 775.

The motion court, inter alia, granted the petition for dissolution. On appeal, the Second Department affirmed the motion court’s order.

The Court’s Decision

The Second Department “agree[d] with the Supreme Court’s determination” that Yemini and Goldberg were so deadlocked that dissolution was in their best interests as shareholders of the corporation. “The evidence,” concluded the Court, “demonstrated that the dissension between” Yemini and Goldberg was so severe that it “‘posed an irreconcilable barrier to the continued functioning and prosperity of the corporation.’” Quoting Matter of Kaufmann, 225 A.D.2d at 775. Accordingly, dissolution under BCL § 1104 was appropriate.

Takeaway

Irreconcilable dissention or deadlock is among the most common forms of conflict in a closely held corporation. An impasse in the decision-making process of a corporation (i.e., deadlock) can occur on the director and shareholder level. If the impasse cannot be consensually resolved, the corporation’s business may incur commercial and economic loss.

Close corporations are particularly vulnerable to deadlock. Close corporations are typically composed of family or friends who are actively engaged in the management of the corporation. They usually have a large portion of their personal wealth invested in the business and contribute most, if not all, of their time and energy in trying to make the corporation a successful enterprise.  If dissension develops among the owners of a close corporation, participants who wish to leave or dissolve the entity may be unable to do so. Because of the potential for deadlock in close corporations, state legislatures and the courts have developed mechanisms for shareholders to obtain relief under circumstances in which continuing the corporation provides no benefit to them. In New York, the mechanisms are BCL §§ 1104 and 1104-a.

Under the BCL § 1104, dissolution is generally appropriate where deadlock impedes the daily functioning of the corporation such that the corporation’s prosperity is no longer viable. In ANO, the Court found that the dissention between shareholders irreconcilably prevented the corporation from functioning effectively and profitably.

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